Canada's Trudeau faces election risk after firm's pipeline surprise

OTTAWA, April 15 (Reuters) - Canada's government got just 24 hours notice that it would be thrust into a political and economic crisis by an ultimatum from a pipeline operator, government sources said, leaving Prime Minister Justin Trudeau scrambling for options in a dispute that could damage his re-election chances.

The Kinder Morgan Canada pipeline issue has pitted Ottawa against the Pacific province of British Columbia and could turn into a constitutional crisis, derail Trudeau's energy strategy and dent business confidence.

Trudeau broke off a foreign trip to hold an emergency meeting on Sunday with the premiers of two provinces locked in a standoff over the pipeline after the company set a May 31 deadline to resolve the impasse or it would walk away.

Federal officials had been talking to the company since February when British Columbia's left-leaning coalition, which includes the Green party, made clear it would delay the planned expansion of the Trans Mountain pipeline from Alberta's oil sands to the coast.

But the government had no idea that Kinder Morgan Canada was about to drop a bombshell.

"Kinder Morgan's announcement on Sunday was unexpected," said a senior government official who declined to be identified given the sensitivity of the situation. "We had 24 hours' notice."

The move by Kinder Morgan Canada, which was spun off by its U.S. parent last year, puts pressure on Trudeau to solve the problem without alienating voters in British Columbia or presiding over an investment failure ahead of 2019 elections.

A second federal government source said the prime minister and senior cabinet members had worked behind the scenes for weeks, pressing British Columbia to change its position.

"If we're talking of things going awry, British Columbia knew this was federal jurisdiction," said the source.

The operator wants to almost triple the capacity of the existing pipeline. Ottawa, which approved the project in 2016, insists it has jurisdiction. British Columbia's government, elected in 2017, disagrees, citing the risk of a spill.

"I do believe we have a mandate to defend the coast," provincial Premier John Horgan told reporters on Friday.

Trudeau won power in 2015 partly thanks to extra seats his Liberals won in British Columbia as well as increased support from environmentalists. Cracking down too hard would cost him support in both camps, leaving him with a weak minority government in the October 2019 elections.

Long-standing tensions over the pipeline meant Liberals in British Columbia were already nervous about softening support before Kinder Morgan Canada's ultimatum, said a Liberal party official.

The Liberals also have to pick up seats in the province of Quebec, which has a strong green tradition.

"It wouldn't really take a lot to tip the government into minority territory," said pollster Nik Nanos of Nanos Research.

"If you're looking at hard political calculus, the prime minister realistically has to tilt in favor of the environment because if he doesn't that will kill him in Quebec."

During Sunday's meeting, Trudeau will lay out the various financial, regulatory and legal options, said the second government source.

"It's not a matter of getting angry, or being mean or nice about it - he will lay out the facts," said the source, who spoke on condition of anonymity.

The federal and Alberta governments both say they could take a stake in the pipeline to keep the project alive, with Alberta's premier saying her province could even buy it outright. Kinder Morgan Canada has said it was open to discussions but did not elaborate.

The first government source there was a "huge gray zone" of possible government help, citing the past bailout of the auto industry in 2009, federal loan guarantees for a hydro-electric project and Ottawa's investment in an offshore energy project.

Toronto-Dominion Bank Deputy Chairman Frank McKenna, a member of Alberta's pipeline advisory taskforce, said he raised the issue with Trudeau in a recent call and that Ottawa has to "provide deal certainty ... a backstop".

"That could be something in the nature of an indemnity agreement or a guarantee against potential losses that would come from political instability and not based on normal construction risk," said McKenna, a former premier of New Brunswick. TD Bank is Kinder Morgan Canada's biggest lender.

"At the end of the day this pipeline can't be allowed to fail, it would be a huge blow to the leadership of the country and to the image of the country." (With additional reporting by Matt Scuffham in Toronto, Julie Gordon in Vancouver;)